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Tackling Mortgage Crisis by the State Government

Tackling Mortgage Crisis by the State Government

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Published by: Carrieonic on May 17, 2009
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brookings
 
May 2008
Introduction
During 2006, the United States saw a considerable upswing in the number of 
w mrtgag dfaults ad frclsur ligs. B 2007, that upswig had b
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cm a tidal wa. Tda, atial hmwrship rats ar fallig, whil mrtha a milli Amrica familis ha alrad lst thir hms t frclsur.Acrss th cutr, bardd huss ar apparig  c stabl blcks. Sm
of the hardest hit communities are in older industrial cities, particularly Midwest-
r citis such as Cllad, Dtrit, ad Idiaaplis.
2
 Although most media attention has focused on the role of the federal government
i stmmig this crisis, stats ha th lgal pwrs, acial rsurcs, adplitical will t mitigat its impact. Sm stat grmts ha tak acti,
negotiating compacts with mortgage lenders, enacting state laws regulating
mrtgag ldig, ad cratig s-calld “rscu fuds.” Grrs such as
Schwarzenegger in California, Strickland in Ohio, and Patrick in Massachusetts
ha tak th lad  this issu. Stat acti s far, hwr, has just bgu taddrss a still ufldig, multidimsial crisis. If th issu is t b addrssd
successfully and at least some of its damage mitigated, better designed, compre-
hsi stratgis ar dd.This papr dscribs hw stat grmt ca tackl bth th immdiat
problems caused by the wave of mortgage foreclosures and prevent the same
thig frm happig agai. Aftr a shrt riw f th crisis ad its ffct 
America’s towns and cities, the paper outlines options available to state govern-
mt, ad ffrs t spcic acti stps, rprstig th mst apprpriat ad
potentially effective strategies available for coping with the varying dimensions of 
th prblm.
Tackling the MortgageCrisis:
 
10 Action Steps forState Government
Alan Mallach
1
“Althoughmost mediaattention hasfocused onthe role of the federalgovernmentin stemmingthis crisis,states havethe legalpowers,
fnancial
resources,and political will tomitigate itsimpact.”
The mortgage foreclosure crisis has become an issue of growing concernover the past two years, one without easy remedies. While most atten-tion has focused on what the federal government should do to manage thefallout, states, too, play a vital role in the process. This paper describes how 
the mortgage crisis came to be, and the damage it has so far inicted. It 
then provides a set of concrete action steps that states can take to mitigateits impact on families and neighborhoods—and prevent a similar situationfrom occurring in the future.
ReSToRInG PRoSPeRITy InITIATIve FRoM THe MeTRoPoLITAn PoLICy PRoGRAM AT BRooKInGS
 
brookings
 
May 2008
1 The Origins and Extent of the Crisis
Th frclsur crisis facig th Uitd Stats tda did t cm ut f whr. It is thutcm f plic chics ad priat dcisis datig back mr tha a dcad. Ab
all, it arose from the creation of the subprime lending industry that emerged from changes
i th acial wrld durig th 1990s. Althugh a full dscripti f that idustr ad itsris ad fall wuld ll a bk, a shrt riw will st th ctxt fr this papr.
The Rise and Fall of Subprime Lending
Th ida bhid subprim ldig is a simpl . Histricall, hmburs dd gdcrdit bfr ldrs wuld ffr a mrtgag. Ths mrtgags wr mad aailabl at asigl r “prim” itrst rat, with l mdst ariatis. Th subprim ldig idustr
emerged to provide loans to borrowers with poor credit who could not qualify for prime
las. Basd  th prpsiti that ths brrwrs ar highr risk, subprim las carrhighr itrst rats tha prim las.
3
This idustr wuld t ha grw, hwr, writ t fr dramatic chags i th acial wrld, icludig:Grwth f crdit scrig basd  acial mdls; this allwd rms such as Fair Isaac ad C. (FICo) t dis sigl crdit scrs fr brrwrs, which claimd tprdict th risk f makig a la t th brrwr;Th ucuplig f hm ldig frm th thrift ad bakig sctrs thrugh bak c
-solidation and restructuring, and the growth of independent mortgage companies and
brkrs;Scuritizati f mrtgag dbt b Wall Strt rms, which cratd istmt pls b
bundling mortgages together and selling them on worldwide capital markets to inves-
trs; adTh all but isatiabl dmad frm istrs fr highr ild istmts, dmad that
was unmet as a result of low, long-term interest rates worldwide on traditional invest-
mt hicls.Sic th 1990s, mrtgag brkrs ha packagd mrtgags fr th acial istitutisthat prid th fuds. Ths istitutis i tur budld mrtgags tgthr, sllig thm
to Wall Street investment banks, which aggregated them into marketable securities and
sld thm i shars t istrs.
4
Th istmt bakrs hird trusts t hld th fudsad thr rms, kw as sricrs, t maag th mrtgags i th pl  bhalf f thistrs. Ths sricrs pla a critical rl i th frclsur crisis.I thr, this was a ratial sstm. I practic, hwr, thr was a grat dal wrgwith it. Th ti that, istad f aidig risk,  culd simpl rais th cst  th basis
of the risk involved, coupled with the demand for high-yield investments, set off a raceamong brokers and lenders to create the most mortgages at the highest possible interest
rats. This was curagd b ldr’s us f yild Sprad Prmiums, which ga brkrshighr cmmissis fr makig highr itrst, riskir las.T mt dmad frm istrs fr still highr ilds, brkrs ad ldrs cam up withicrasigl igius was t qualif mr burs ad mak mr las. Th ffrd ad
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 justabl rat mrtgags (ARMs) with “xpldig” itrst rats, which startd ut with a lwitrductr r “tasr” rat that latr skrcktd, usuall aftr tw ars. Athr prductwas “ dc” las, mrtgags mad withut rquirig brrwrs t dcumt thir icmr thr bligatis, at  highr itrst rats. othr “xtic” mrtgags icludd ga
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ti amrtizati mrtgags ad s-calld opti ARMs, a frm f adjustabl rat mrtgag
in which borrowers could choose—within certain bounds—how much or how little to pay on
thir mrtgag ach mth. All carrid itrst rats far ab what prim ldrs chargdcustmrs with bttr crdit. Aftr 2003, gratr umbrs f subprim las wr ithr 
 
brookings
 
May 2008
ARMs, -dc las, r thr xtic las. I fact, 92 prct f all scuritizd subprimmrtgags rigiatd i 2006 wr adjustabl rat mrtgags.
5
 
A scd wa f gratig mr busiss was curagig hmwrs t rac.
Aggressively marketing their products to elderly or lower-income homeowners in urbanneighborhoods and taking advantage of their lack of sophistication, subprime lenders made
millis  racig las, smtims racig th sam hus rpatdl. Masubprim ldrs strd brrwrs, ft black r Lati familis, it high-cst mrt
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gags wh th culd ha qualid fr lss xpsi las. estimats suggst thatbtw 30 prct ad 50 prct f all subprim brrwrs culd ha qualid fr lssxpsi las.
6
 
Arguig that th wr “dmcratizig crdit,” subprim ldrs curagd millis f br 
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rwrs t assum las that th wuld mst likl b uabl t rpa. Althugh warig
voices were heard early, the federal government hoped to increase the number of low-
icm ad mirit hmwrs, ad Fdral Rsr Chairma Ala Grspa wasphilsphicall ppsd t rgulati.
7
So long as home prices were rising in most states,which was the case through 2005, most borrowers had enough equity to enable them to
sll thir hm r rac thir hms shuld th b uabl t mak thir pamts.Mawhil, th umbr f subprim las kpt grwig. B 2006, th rprstd mrtha  f r fur w mrtgag las.B th d f 2006, wh th husig bubbl burst, ldrs had mad mr tha 15 millisubprim las. Mr tha -half f ths wr utstadig, th balac haig b r
-
acd r frclsd.
8
Millions of these were ARMs, whose low introductory interest rates
wr bgiig t rst t much highr rats. With hm prics fallig, brrwrs culd lgr xtricat thmsls frm uaffrdabl las. Th rsultig frclsur wa was
all but inevitable, hitting particularly hard in many urban areas, where more than one-half of 
w mrtgag las wr subprim las.
9
 
Althugh th rst wa f dfaults was cctratd amg th mst qustiabl las,
as the crisis deepened, foreclosure rates began rising among other mortgages as well,
icludig xd-rat subprim mrtgags ad th s-calld Alt-A mrtgags, a itrmdi
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at catgr btw subprim ad prim las. B 2007, dliqucis amg xd-ratsubprim las ad prim adjustabl-rat las wr als risig rapidl.

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